December 1, 2010

Classic Mistakes in Exit Strategy vol. 6: The Valuation / Value Proposition Shuffle

By Eric Michaels, Senior Analyst, MergerTech Advisors
Selling your business dispassionately is hard.  While you know that incorporating “rate of return” and other investment concepts into the process makes logical sense, so many unknown factors can create confusion and uncertainty.  While this discomfort is a natural and healthy part of the process, making decisions based on irrational or irrelevant data points could not only prevent you from exploring a reasonable offer, but could also become the rationale for rejecting future offers even if they beat your prior expectations.

One of the primary reasons M&A advisors are hired is to help business owners better understand the valuation of their business.  This is accomplished through either an analysis of future profits or a comparison to other historically similar transactions.  Nevertheless, uncertainty exists when an offer hits the table.  Most business owners ask, “Is this the best I can do?”  Depending on your perspective, there are two answers:

  1. You will never know for sure.  There is always the possibility that there is a buyer you have not considered who could offer you something significantly better.  This buyer could see a tremendous business opportunity in working with you or could offer you a considerably higher valuation out of their personal ignorance to fundamental market value.  This rarely happens.  Buyers naturally try to pay as little as possible for their acquisitions; and perform a significant amount of due diligence and business review before making any offer whatsoever.  It is important to consider that if you or your advisor has not encountered such an eager buyer after running a thorough process, it may simply not exist.  If there is an offer on the table, focus your energy on improving that offer rather than chasing after new buyers somewhere over the rainbow.
  2. Yes, it is the best offer because you prefer this offer to the other offers on the table.  If you have successfully solicited multiple offers, you should work towards using the competitive buyer environment to your advantage.  Your business is a unique asset and is in limited supply.  The high bidder shall prevail if they are truly interested in this acquisition.

This leads us to two questions that a seller may ask when balancing their company’s valuation with buyer responses.  When only a few (or one) buyers step forward with an offer, sellers ask, “Does this offer represent the market value of my business?”  This is an important question because a valuation is on the table with nothing to compare.  When many buyers present offers that are of similar value, a seller will get a sense of what a buyer is willing to pay for their business.  Without competitive offers, it is important for the seller to rely on the experience of their M&A advisor to better understand the offer and determine their best course of action.

In contrast, when a seller receives an overwhelming amount of interest from one or more buyers, a seller may get the impression that their business is worth more than they had previously imagined.  “Why are so many buyers willing to pay so much for my business?”  “Do they know something that I do not?”  Very often, larger buyers are able to unlock value in a small to medium sized business that did not previously exist.  This is because they are able to combine business units, expertise, IP, brand, and sales channels to create new business opportunities.  Rather than shying away from what may sound like a “too good to be true” situation, make use of your M&A advisor and discover what the buyer’s plans are.  Gaining this insight will allow your advisor to better understand how much your business is truly worth to them and begin a competitive negotiating process.

Whether your company presents an attractive value proposition to many or few buyers, it is important to understand that your company’s valuation is driven by your business fundamentals, the state of the M&A economy, understanding the buyers, and your negotiating aptitude.  If you and your advisor can run a competitive process, pinpoint what a buyer is looking for, and skillfully negotiate a purchase agreement, you should feel confident in the offer that you ultimately accept.